Japanese Outsider Freeze-Out Thawing

Japanese investors have historically played the role of the hometown referee, favoring the local teams and giving foreign asset management firms a slim chance of staying in the game. However, the Japanese appear tired of giving the home team a free pass. That has made selling financial services in Japan a whole new ballgame.

Foreign asset managers have proved, as of late, that growth is possible for those that hail from outside the island. Five out of every six foreign or foreign-affiliated asset managers in the Japanese market defended or gained market share over the last three years through March, according to a recent study by Cerulli Associates of Boston. Of the 80 largest asset managers active in Japan, 70%, or 56 of them, gained or maintained their share of the industry. Of those successes, 35, or nearly 63%, were foreigners.

Japan is considered a tough market to break into because of the keiretsu relationship, a constellation of national companies that are connected through cross-ownership, according to Cerulli analyst Itsuko Hatanaka, co-author of the report. "In general, brokerages choose products of affiliated asset managers, regardless of [the] quality of the products, and it has made it extremely difficult for foreigners to penetrate into the market."

However, through recent changes in investors' needs and the start of banks selling investment products, the situation is changing, Hatanaka said. "The key to success for foreign players is a solid entry strategy with diversified, interesting foreign products." The main reason for the shift in sentiment is due to Japanese investors' dislike for razor-thin interest rates and a stagnated market, Hatanaka said, adding that this is a trend that will be maintained for a while.

Contributing to this trend is the stumbling of Japan's previously dominant brokerages. Their money-management vehicles were plagued by overly aggressive and poorly implemented investment policies, a development that led to investors' waning faith and subsequent drain in assets under management.

Allianz Dresdner Asset Management, Alliance Capital Management, Wellington Management and Barclays Global Investors have all done well recently, thanks to, in part, increased interest in foreign portfolios, a combination of longer-term objectives and the continued rise of bank distribution. The fund management operations of Prudential Financial and GE Asset Management also have been boosted by their parent companies' Japanese insurance operations.

Martin Schulz, director of international equity investments for National City Investment Management Co., advisor to the Armada Funds, also said he expects the thawing of the Japanese foreigner freeze-out to be a long-term trend aided by the effects of globalization.

"Japanese society historically has been very closed. Only in the last few years has it started to open. Now local Japanese people are just much more willing to look at something that is not Japanese," Schulz said, adding that "it's both a cultural as well as economic" phenomenon. "The other thing it underscores is that Japanese brokers have had their share of poorly implemented investment policies. Japan is definitely a market where global money managers can make gains," he said. "With its neighbor China growing like mad, it's going to be the Chinese century. Japan's going to have to wake up either way."

Ben Phillips, managing director at Cerulli and co-author of the report, said the recent appetite for foreign-objective funds, which is unusual for Japan historically, now makes sense given the incredibly thin yields on Japanese bonds in a deflationary environment. "Japanese investors used to invest heavily in money market funds run by major brokerages, until they found out that some invested in Enron corporate and Argentine sovereign debt, thus risking their bulletproof' status," Phillips said. As money markets shrank, brokerages' market share slid.

Foreign firms have no advantages over local ones, except that right now they offer foreign products, he said. However, many of the foreign firms that are well entrenched in that market have learned to adapt and to make their strategies look and feel more Japanese, Phillips noted.

Assets in market segments that are most addressable by fund managers are expected to grow at a 6% compound annual growth rate through 2008, double the 3% rate predicted for local mutual fund assets, according to the Cerulli report.

"Investors increasingly want performance, but also want risk management and monthly income streams - particularly because many Japanese fund investors are older retirees seeking an income stream. They aren't looking at firms' relative market share. That's inside baseball for the fund companies to measure their own progress. They're looking for star ratings and income yields, just like their counterparts in the U.S.," Phillips said.